Unusual Suspects Boost First Quarter Office Rebound

Here’s another sign that the recovery in the office market is gaining momentum. Across the nation, the office vacancy rate slid by 60 basis points from 14.7% to 14.1% during the first quarter — the largest quarterly decline in six years. Real estate research firm Reis Inc. also reported this week that effective rents jumped by 2% during the quarter, which was the fastest rate in more than five years and double the pace of the previous quarter.

Even more encouraging, perhaps, is the news that some long-depressed markets, including Chicago and Dallas, posted strong gains in the first quarter. Grubb & Ellis reports that the Dallas market had 1.29 million sq. ft. of net absorption in the first quarter — a far cry from the 130,000 sq. ft. of negative net absorption in the first quarter of 2005. In Chicago, net absorption quintupled from 251,000 sq. ft. in 2005 to 1.27 million sq. ft. this year.

The last time Dallas posted 1 million sq. ft. of positive quarterly absorption was six years ago. A major factor in the turnaround in first-quarter was expansions at law firms, Grubb & Ellis reports. Meanwhile, in Chicago several large tenants signed new leases, driving vacancy down to 19% from 19.9% in the first quarter of this year.

“It really seems like a different set of markets contributed to the first quarter office recovery,” says Bob Bach, national director of research at real estate services firm Grubb & Ellis.

While major contributions to the office recovery were made in key coastal markets such as New York City and Los Angeles, it’s telling that Chicago and Dallas started the year on such a strong note. This is not to suggest that both cities are out of the woods, however: Dallas was still 21.7% vacant at the end of March, and Chicago was hovering only 100 basis points under 20% vacant. Yet it’s also unclear if this momentum can be sustained during the second quarter.

What’s driving rental growth is the national economy, which may have picked up steam since New Year’s Day. First-quarter GDP, for example, is expected to register as high as 5% — and that would come in higher than the 3.8% growth rate achieved in the first quarter 2005 (not to mention higher than the 1.7% GDP from the fourth quarter 2005).

But GDP really doesn’t tell the whole story. A baseline comparison between cumulative job growth data from the previous expansion (1996 to 1999) and the current one (projected out from midyear 2006 through the end of the first quarter 2009) finds that most key office markets will produce far fewer jobs this time around.

According to an analysis prepared by Property & Portfolio Research (PPR), Dallas posted 14% cumulative office-using job growth between 1996 and 1999 —second to only Seattle. During the current expansion, however, Dallas will post just 7% job growth. The same dynamic holds true for Chicago, which boasted 6% job growth in the previous expansion. PPR expects Chicago’s labor expansion to barely hit 4% over the next three years.

The irony of this analysis is that New York, Boston, Los Angeles and San Francisco are expected to post the slowest job growth of all key metro markets over the next three years. Conversely, cities like Seattle, Dallas, Houston and Atlanta should lead the market in cumulative job growth. It also means that three of the four projected top performing markets will be landlocked.

“It’s good to see these markets joining the recovery phase after a long time,” says Bach of Grubb & Ellis. “They’re still very late to the party, but you can’t deny that they are recovering.”